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Risk Attitude, Beliefs Updating and the Information Content of Trades: An Experiment

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  • Bisière, Christophe
  • Décamps, Jean-Paul
  • Lovo, Stefano

Abstract

We conduct a series of experiments that simulate trading in financial markets and which allows us to identify the different effects that subjects’ risk attitudes and belief updating rules have on the information content of the order flow. We find that there are very few risk-neutral subjects and that subjects displaying risk aversion or risk-loving tend to ignore private information when their prior beliefs on the asset fundamentals are strong. Consequently, private information struggles penetrating trading prices. We find evidence of non-Bayesian belief updating (confirmation bias and under-confidence). This reduces (improves) market efficiency when subjects’ prior beliefs are weak (strong).

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Bibliographic Info

Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 09-036.

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Date of creation: May 2009
Date of revision: May 2012
Publication status: Published in Management Science.
Handle: RePEc:tse:wpaper:21946

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  1. Mathias Drehmann & Jörg Oechssler & Andreas Roider, 2002. "Herding and Contrarian Behavior in Financial Markets - An Internet Experiment," Bonn Econ Discussion Papers bgse25_2002, University of Bonn, Germany, revised Apr 2003.
  2. Steffen Huck & Joerg Oechssler, 1999. "Informational cascades in the laboratory: Do they occur for the right reasons?," Experimental 9901001, EconWPA.
  3. Bogaçhan Çelen & Shachar Kariv, 2004. "Distinguishing Informational Cascades from Herd Behavior in the Laboratory," American Economic Review, American Economic Association, vol. 94(3), pages 484-498, June.
  4. Dorothea K¸bler & Georg Weizs”cker, 2004. "Limited Depth of Reasoning and Failure of Cascade Formation in the Laboratory," Review of Economic Studies, Wiley Blackwell, vol. 71(2), pages 425-441, 04.
  5. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
  6. Decamps, Jean-Paul & Lovo, Stefano, 2006. "Informational cascades with endogenous prices: The role of risk aversion," Journal of Mathematical Economics, Elsevier, vol. 42(1), pages 109-120, February.
  7. Marco Cipriani & Antonio Guarino, 2005. "Herd Behavior in a Laboratory Financial Market," American Economic Review, American Economic Association, vol. 95(5), pages 1427-1443, December.
  8. Williams, Arlington W., 2008. "Price Bubbles in Large Financial Asset Markets," Handbook of Experimental Economics Results, Elsevier.
  9. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
  10. Hirshleifer, David & Teoh, Siew Hong, 2001. "Herd Behavior and Cascading in Capital Markets: A Review and Synthesis," MPRA Paper 5186, University Library of Munich, Germany.
  11. Anderson, Lisa R & Holt, Charles A, 1997. "Information Cascades in the Laboratory," American Economic Review, American Economic Association, vol. 87(5), pages 847-62, December.
  12. Jean-Paul Decamps & Stefano Lovo, 2006. "A note on risk aversion and herd behavior in financial markets," The Geneva Papers on Risk and Insurance Theory, Springer, vol. 31(1), pages 35-42, July.
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